Question

Your company has earnings per share of $8. It has 1 million shares​ outstanding, each of which has a price of $60. You are thinking of buying​ TargetCo, which has earnings per share of

​$4​, 1 million shares​ outstanding, and a price per share of $45. You will pay for TargetCo by issuing new shares. There are no expected synergies from the transaction. Complete parts a through d below.

a. If you pay no premium to buy​ TargetCo, what will your earnings per share be after the​ merger? Round to nearest Cent

b. Suppose you offer an exchange ratio such​ that, at current​ pre-announcement share prices for both​ firms, the offer represents a 15​% premium to buy TargetCo. What will your earnings per share be after the​ merger?Round to nearest Cent

c. What explains the change in earnings per share in part​ a? Are your shareholders any better or worse​ off?

d. What will your​ price-earnings ​(​P/E​) ratio be after the merger​ (if you pay no​ premium)? How does this compare to your ​(​P/E​) ratio before the​ merger? How does this compare to​ TargetCo's pre-merger ​(​P/E​) ​ratio?

Answer 1

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Answer:

a)

Total earnings: ($8 * 1 million shares) + ($4 * 1 million shares) = $12 million
Target Co. shares to buy: $45 / $60 = 0.75* 1 million shares = 750,000
Total shares after merger: 1 million + 750,000 = 1.750 million
Earnings per share after merger: $12 million / 1.750 million = $6.857

b)

Target Co. premium per share: $45 * 1.15 = $51.75
Target Co. shares to buy: $51.75 / $60 = 0.8625 * 1 million shares = 862,500
Total shares after merger: 1 million + 862,500 = 1.8625 million
Earnings per share after merger: $12 million / 1.8625 million = $6.4423

c)

The earnings per share after the merger is lower than my company’s earnings per share
and higher than Target’s earnings per share. My shareholders are better off because
taking the average of $8 & $4 EPS is $6; the earnings per share after the merger is still
higher by $0.857

d)

Total company value: ($60* 1 million) + ($45 + 1 million) = $105 million
Total earnings: $12 million
Price earnings ratio after merger: $105 million / $12 million = 8.75
Price earnings ratio before merger (Company): $60 million / $8million = 7.5
Price earnings ratio before merger (Target): $45 million / $4 million = 11.25
***P/E ratio of my company is lower before the merger compared to P/E ratio after the
merger. P/E ratio of Target is higher before merger compared P/E ratio after the merger